Income Tax Appellate Tribunal - Hyderabad
Dy. Cit, 3(1) vs Sri K.S.N. Enterprises P. Ltd., Sri Kode ... on 31 January, 2006
Equivalent citations: [2007]105ITD375(HYD), [2008]303ITR229(HYD), (2007)108TTJ(HYD)940
ORDER
1. All these appeals are filed by the Revenue, directed against the separate but identical orders of the CIT (Appeals) I, Visakhapatnam, camp Hyderabad, and relate to assessment year 1993-99. As the issues arising in all these appeals are common, for the sake of convenience, at the request of both the parties, the appeals are clubbed and heard together and disposed of by way of this common order.
2. The grounds of appeal raised by the Revenue read as, under:
1. The CIT (A) erred on facts and in law.
2. The CIT (A) ought not to have held that the provisions of Section 28(ii) are not applicable to consideration received on termination of contracts.
3. The CIT (A) ought to have appreciated that the restrictive covenant is a ruse adopted by the assessee to reduce the incidence of taxation.
4. The CIT (A) ought to have appreciated that in the assessee company line of business goodwill does not exist.
5. Any other ground that may be urged at the time of hearing.
Brief facts of the case are as follows.
3. The assessee was engaged in the business of distribution of soft drinks like Coca Cola, Thums Up, Limca, Maaza etc., which were produced by Spectra Bottling Company Ltd. (hereinafter referred to as Spectra). Spectra was a franchisee of The Coca-Cola Company, USA (hereinafter referred to as TCCC). The assessee states that it had developed a distribution network for marketing the soft drinks produced by Spectra and that it has its own fleet of vehicles which are sent to various distribution points as per requirement. It further states that the assessee, during the course of its business of distribution, had built and developed distribution network as it was also responsible for the proper conduct of the business of Spectra. The Franchisee Agreement given to Spectra was terminated by a Business Sale Agreement by TCCC and the business was purchased by Bharat Coca-Cola South East Pvt. Ltd. (hereinafter referred to as BCC). BCC purchased the business of Spectra as a going concern. Pursuant to the business sale agreement between Spectra and BCC, the latter entered into an agreement with the assessee to take over the distribution activity by paying certain consideration for acquisition of goodwill and for non-compete agreement. Two separate agreements were drawn up - one for taking over of goodwill and the other for non-compete agreement. The assessee has reflected the amount received by it under these two agreements, in its Reserves and Surpluses Account by treating the receipt as a capital receipt.
4. During the course of scrutiny proceedings under Section 143(3), on enquiry made by the Assessing Officer, the assessee contended that the receipts in question were capital receipts and that the amount received in pursuance of non-compete agreement was for restrictive covenant and thus a capital receipt and that the amount towards sale of goodwill had been offered to tax as a capital gain and that exemption was claimed under Section 54EA. The AO rejected the contentions of the assessee and the grounds for rejection are contained in paragraphs 37 and 38 at pages 12 and 13 of his order, which are reproduced below for ready reference:
37) To sum up the amount received by the assessee for the loss of income/earnings is a revenue receipt. Any amount received in lieu of the profits which would have been earned if the business in the said products had remained with the assessee, would partake the same character as profits. It is held accordingly also for reasons as follows:
(a) The amount received in the guise of compensation for restrictive covenant is in the course of business of the assessee, therefore, liable to be taxed as such.
(b) It is a well known fact that in this line of business (Soft Drink Industry), it has been a practice to change transactions and therefore, the amount received by the assessee is in the course of the business and therefore, is a revenue receipt.
(c) In the present case, there was not even a threat of competition, much less there was a competition at all as the business was being carried on by the assessee independently.
(d) The so called competition is only imaginary and make belief arrangement and it is incomprehensible that the assessee who is a distributing agent of Spectra Bottling Co. Ltd., who is also licensed to deal in products in question by the BCC, would be in a position to compete with the BCC in the very same line of business. When there was no competition in the business there cannot be any restrictive covenant and the agreements are only self serving colourable devices to claim the revenue receipt as capital receipt in the guise of compensation over restrictive covenant.
(e) The assessee did not at any stage have, any enforceable or otherwise agreement/understanding/contract with the BCC.
(f) In the books of accounts, the principal company (BCC) has treated the amounts paid as a revenue expenditure and whereas the assessee claimed as received on capital account, This is nothing but a planned tax evasion tactics, attempted by the principal company and the assessee company, working in tandem.
38) In view of the above discussion, and also for the reason that the principal company i.e. M/s BCC has treated the entire amount paid as revenue expenditure, I hold that receipt Rs. 4 crores in the hands of the assessee company constitutes revenue receipt and is exigible to tax.
5. Alternatively, the AO held that the amount is liable to tax as compensation for termination of agency under Section 28(ii) of the Income-tax Act, 1961. The detailed discussions are contained in paragraphs 40 to 64 of the assessment order. Further, an alternative contention was put up by the AO that if the receipt is to be considered as a capital receipt and not a receipt towards compensation for termination of agency, it should be viewed as a sale of business as a going concern and thus it would attract short-term capital gains tax under Section 50(2) of the Act. As he had taken a view that the entire consideration of Rs. 4 crores is a revenue receipt, he has not separately worked out the capital gain.
6. On appeal, the first appellate authority, after considering in details the submissions of the assessee, which are reproduced by him at page 2 paragraph 4 to page 7 paragraph 7, come to a conclusion that-(a) Invoking the provisions of Section 28 and discussing the various case law by the AO from para 42 onwards is not relevant as the appellant is not a management agent nor the agreement with Spectra was an agency agreement and thus the provisions of Section 28 do not apply to the agreement entered into by the assessee with BCC; (b) The AO's observation that the assessee company did not have any. goodwill is not acceptable; (c) The amount received by way of non-compete agreement was not an amount received as sale price for selling of its business as a going concern and by this agreement, the assessee was prevented from doing business in similar line and also prevented in disclosure of information to any other person, particularly a rival, and the assessee had to change its registered name also and as such it is a capital receipt. 'The learned CIT (A) relied on the judgment of the Hon'ble Supreme Court in the cases of Kettlewell Bullers & Co. Ltd. v. CIT 63 ITR 261, and Gillanders Arbuthnot & Co. Ltd. v. CIT 53 ITR 288, as well as in the case of CIT v. Best & Co. (P) Ltd. 60 ITR 11, and held that the assessee had lost the entire source of income from this business activity and the receipt consequent to termination of business is to be treated as a capital receipt only. He directed the AO that the amount received by way of goodwill should be subjected to tax under the head 'capital gain' and the claims of the assessee as per provisions of Section 54EA have to be allowed and the amount received by the assessee under non-compete agreement is not liable to tax as it is a capital receipt. Aggrieved by his orders, the Revenue is in appeal.
7. The learned departmental representative submitted that BCC had taken over a number of bottling companies as going concerns in the entire country, which involved a few hundred crores of rupees and that when the company had taken over Hyderabad Bottling Co. Ltd. as a going concern for a consideration of Rs. 43 crores, an amount of Rs. 17 crores was paid to the four directors of Hyderabad Bottling Company and there was no payment whatsoever to the distribution company connected with Hyderabad Bottling Company either towards goodwill or towards non-compete agreement, though both the groups have more volume of business as compared to ¦ Spectra. With this background, the learned Counsel submitted that the first appellate authority was wrong in holding that there was certain confidential information that the distribution company possessed. He vehemently contended that there was no confidential information whatsoever and the amounts received in the guise of compensation for non-competition is actually an amount received in the course of business of the assessee and, therefore, liable to tax. He took this Bench through the order of the AO and relied on the same. In brief, the propositions are:
(a) The receipt in question is a revenue receipt;
(b) That the terms and conditions stipulated in the agreement between the assessee company and Spectra while appointing it as a distribution agency, clearly demonstrate that the sale is undertaken by the manufacturers i.e. Spectra and the role of the distributor is only to collect the goods from the manufacturer from their yard and make delivery at retailers and district dealers;
(c) It was the manufacturer who would decide all the important aspects and the distributor was merely to transport the products from the bottler to the assigned dealer network;
(d) From this agreement, it was clear that the assessee company did not have any confidential information of any sort which could be used against the bottlers or his principal and it has no control over the product, strategy for marketing, choice of dealership or the volume of business etc.; in sum, it had no control over the conduct of the business of Spectra;
(e) That the formula of the concentrate supplied by TCCC, which is the base material, is not known to the distributor;
(f) That the confidential information comprised in or derived from manuals, instruction, catalogues, book-lets, data disks, tapes, source codes, formula cards and flow charts relating to the business was all available with BCC and TCCC as it was those companies which had supplied them and thus that information cannot be used against TCCC;
(g) That the period of restraint is only five years whereas the bottlers and TCCC had taken two decades to build up market brand: in brief, the Revenue's case is that the agreement in question is a tailor-made agreement wherein the parties have joined to execute a self-serving document with a view to avoiding payment of tax;
(h) That the assessee was neither a manufacturer of a specific brand of products which has generated certain goodwill over a period of years nor is having any trade-mark for any of the products and thus the question of goodwill does not arise and that the agreement regarding goodwill is also an edifice. The assessee is one among several distributors in the state of Andhra Pradesh for these products and as the brand name is Coca Cola, there is no influence of the distributor over the sales, either positively or negatively;
(i) That the assessee company has no technical competence or financial strength to compete with a multi-national giant like BCC and thus, the so-called competition is only imaginary and the receipt in question being termed as non-compete fee is only a guise;
(j) That the ratio of the judgment of the Hon'ble Supreme Court in the case of Mc Dowell & Co. Ltd. v. Commercial Tax Officer 154 ITR 148, applies as this is a colourable device;
(k) That if it is not accepted that the receipt in question was a revenue receipt, then, alternatively, the receipt is taxable under Sub-clause (a) of Clause (iv) of Section 28. For this proposition, the learned DR took this Bench through the findings of the AO and relied on the same.
The learned departmental representative emphasized that the Revenue relies more on the provisions of Section 28(ii) and that the transaction falls within the ambit of the provisions, making it liable to tax. He also relied on the following case laws:
Kettlewell Bullen and Company Ltd. v. CIT 53 ITR 261 (SC) Vadilal Soda Ice Factory v. CIT 80 ITR 711 (Guj) at 720 CIT v. Dr. R.L. Bhargava 256 ITR 42 (Delhi).
K. Rama Samy v. CIT 261 ITR 358 (Mad).
Chemplant Engineers (P) Ltd. v. CIT 234 ITR 23 (Mad) Blue Star Ltd. v. CIT 217 ITR 514 (Bombay) CIT v. Manna Ramji & Co. 86 ITR 29 (SC) He, therefore, requested that the order of the CIT (A) be set aside.
8. The learned Counsel for the assessee, on the other hand, reiterated the contentions raised by him before the first appellate authority. He took this Bench through paragraph 4 at pages 2 to 6 of the order of the CIT (A), wherein the first appellate authority has reproduced the written submissions made by the assessee before him. He pointed out that the CIT (A) has dealt with the nature of the restrictive covenant at page 10 of his order and also reproduced certain portions of the agreement and relied on the observations. The salient features of his submissions areas follows:
(a) The AO's finding is that the assessee did not have any written agreement with TCCC while commencing its business and that the distribution agreement was with Spectra.
(b) The restrictive covenant in question was not an empty formality as TCCC was aware that over a period of years the assessee had established a wide distribution network and developed outlets which increased the turnover of the product and the confidential information related to such efforts made by the assessee for setting up distribution network.
(c) TCCC's interest was to neutralise the assessee for the benefit of its business and prevent it from helping its rivals.
(d) The AO has no material in his possession to doubt the genuineness of the averments in the agreement.
(e) The receipt was in pursuance of a restrictive covenant and thus a capital receipt.
He relied on the following case laws:
1) Kettlewell Bullers & Co. Ltd. v. CIT 63 ITR 261(SC)
2) Gillanders Arbuthnot & Co. v. CIT 53 ITR 288 (SC)
3) CIT v. Best & Co. Pvt. Ltd. 60 ITR 11 (SC).
4) CIT v. Saraswathi Publicities 132 ITR 207 (Mad)
5) CIT v. Automobile Products of India Ltd. 140 ITR 159 (Bom)
6) Addl. CIT v. Dr. K.P. Karanth 139 ITR 479 (AP)
7) CIT v. G.D. Naidu 165 ITR 63 (Mad)
8) V.C. Nannapaneni v. ACIT 94 ITD 309 (Hyd-ITAT)
9. On the issue of goodwill, the learned Counsel submitted that the AO was wrong in inferring that there is no scope for goodwill in this line of business. He relied on the judgment of the Hon'ble Supreme Court in the case of R.C. Cooper v. Union of India 40 Cos. Cases 325, and submitted that goodwill is an intangible asset and profits earned for asst. years 1996-97, 1997-98 and 1998-99 shows that vast improvement in the business of the assessee. He submitted that TCCC was aware of this position and came forward to make substantial payment by acquisition of goodwill. He relied on the observations of the CIT (A) in paragraph 9 of his order. Alternatively, the learned Counsel submitted that if it is held that this amount was not received for goodwill, then it partakes the nature of a capital receipt similar to the consideration received for restrictive covenant.
10. On application of Section 28(ii), the learned Counsel submitted that the agreement falls within the effect of new Clause (v)(a) of Section 28 introduced with effect from 1-4-2003 and that it does not come within the purview of Section 28(ii)(a), (b), (c) and (d). He took this Bench through Section 28(ii) and submitted that Spectra had nothing to do with the arrangement between the assessee and TCCC and that Section 28(ii) as it stood at the material time does not cover this type of cases. He relied on the judgment of the Hon'ble Supreme Court in the case of CIT v. Podar Cement Pvt. Ltd. 226 ITR 625, and submitted that the new provision, Section 28(ii)(v)(a), is not declaratory and retrospective in nature. He further argued that the reliance placed by the AO on the judgment of the Hon'ble Andhra Pradesh High Court in the ill case of J.R. Kimtee & Sons v. CIT, is misplaced, for the reason that the facts of that case are quite distinguishable as that was not a case of termination of agreement. He vehemently contended that the person paying the compensation was never associated with the transactions involving the creation of agency of the assessee or in its termination and Section 28(ii) does not apply. He further relied on the decision of the Tribunal in the case of N. Sandeep Reddy v. ACIT I.T.A. No. 70/Hyd/2004, as well as in the case of Ambica Chemical Products v. DCIT I.T.A. No. 238/V/2003, dated 26-5-2005, and distinguished the case laws relied upon by the learned departmental representative.
11. After closure of the hearing on 2-12-2005, the learned CIT (DR) filed detailed written submissions as in his opinion the written submissions of the assessee's counsel before the Tribunal contain certain issues which remain to be answered. While submitting that he had orally agreed before the Income-tax Appellate Tribunal, Hyderabad Bench 'B', that he had no objection to treat I.T.A. Nos. 534, 533 and 532/Hyd/2002 as heard along with I.T.A. Nos. 537 and 601/Hyd/2002, as the issues are the same, he would like the Bench to consider his written arguments. The issues in the written arguments are the same as argued in the court and they pertain to -
a) That the assessee is only a transport contractor and not a distributor and that it does not have any confidential information.
b) That the assessee could continue to distribute and transport other products than soft drinks.
c) That the assessee did not have any agreement with TCCC while commencing its business and the distribution agreement was in fact with Spectra and that it could not be understood as to how the assessee could be said to be in possession of confidential information.
d) That though the business compulsions of both the parties who have entered into agreement have to be considered, it is for the assessee to prove before the AO to his satisfaction as to how the business of TCCC will be adversely affected by cancelling the distribution agreement and in the absence of proof to the effect that the business of TCCC would suffer an adverse effect if the assessee continues to be in the business of distributor of soft drinks, the AO was right in arriving at the conclusion. Further, that it is for the assessee to prove that TCCC claimed the above expenditure as capital expenditure and not as revenue expenditure.
e) That the assessee's contention that restrictive covenant is not an empty formality is not supported by the agreement entered into between Spectra and the assessee and that in respect of each and every aspect of work relating to sales, it was only the manufacturer, i.e. Spectra, which took care. He reiterated the contention on confidential information and as to whether it can be said that the assessee has any goodwill. In the other part of the written submissions, he reiterated the contentions raised before the Bench, trying to distinguish the case laws.
12. We have heard rival contentions. On a careful consideration of the facts and circumstances of the case and study of the case laws relied upon by both the parties as well as the arguments advanced, we are of the considered opinion that the order of the first appellate authority has to be upheld for more than one reason. The entire edifice on which the AO based the assessment was that the agreements in question are not bona fide transactions and that these are make-believe or colourable device and thus sham transactions. The AO's finding is that these agreements are dubious methods and subterfuge to avoid tax. We find that these conclusions arrived at by the AO are based on mere presumptions and conjectures and are not supported by any evidence whatsoever. The AO had applied his perception and understanding of the business transaction between the assessee and BCC and ultimately seems to have come to a conclusion that BCC need not have paid any money at all to the assessee company, on the facts of the case as understood by him. The first appellate authority has rightly observed that BCC had not done charity. In this context, the following observations of this Bench of the Tribunal in the case of N. Sandeep Reddy v. ACIT (Hyd) reported in 95 ITD 33, at page 65, para '12, are relevant:
Threat perceptions should be viewed from the angle of NATCO and V.C. Nannapaneni and not from angle of revenue collections. Huge sum of money is not parted by NATCO just like that to an unconnected and unrelated person. NATCO recognised the rights of the assessee as well as his capacity to compete by himself" or joining or Learning no with somebody else.
Now, we consider each of the findings of the AO.
13. The AO came to a conclusion that the only function of the distribution company is to transport soft drinks from the bottlers i.e. Spectra to the assigned dealers. In other words, the function of the assessee company is that of a transporter simplicitor. At paragraph 18 on page 5 of the assessment order, the AO extracted the terms and conditions of the agreement between the assessee and Spectra which is dated 1-8-1994. This agreement was entered into much before the non-compete and goodwill agreements were ever thought of. We reproduce some of the terms and conditions of the distribution agency agreement, which demonstrate that the AO had a preconceived notion and wrong understanding of the function of the assessee company while coming to a conclusion that it was just an agreement for transporting goods and not an agreement for distributorship:- Clause 1 of the agreement:
The goods i.e. Soft Drinks bottled by the manufacturer will be supplied to the distributor who in turn will sell the products to the retailers or district dealers. In the event the rates are changed the manufacturer will inform the distributor with a written notice.
Clause 2:
The manufacturer will prescribe the rates at which the retailer has to sell to consumer and it is the responsibility of the distributor to regulate and supervise the retailer and make sure that the product is made available to the majority of consumers at the suggested retail price.
Clause 4:
The distributor has to service the retail outlets at least once in three days and district dealer at least once in a week during the off season. During the peak season the service frequency will have to be more often and will be determined by the market needs.
Clause 6:
The distributor has to work for business improvement and should take all responsible care to keep up the image of the manufacturer and the Coca Cola Company.
Clause 7:
Sales generation assets such as bottle coolers, hand trolleys, push carts, fountain machine etc., shall be provided by the manufacturer. However, it is the responsibility of the distributor to place them in ideal location with or without security deposit. It is the responsibility of the distributor to see that these assets are not misused.
Clause 9:
Distributor has to pay Rs. 10,00,000/- towards trade deposit on glass bottles on behalf of the manufacturer and details of such transactions will be furnished from time to time by the distributor by raising credit/debit note to the manufacturer.
These terms and conditions clearly demonstrate that the assessee's agreement with Spectra in 1994 was not that of a transporter simpliciter. In fact, all the distributors have substantial sales accounted by them for all these years. Thus, we are unable to persuade ourselves to agree with the factual finding of the AO that there was no requirement whatsoever for BCC to pay goodwill or any other amount to the assessee company for the reason that the agreement between the assessee company and Spectra is one which has no commercial value as it was a simple transportation of soft drinks contract and not an agreement wherein the distributor had a number of obligations along with rights and duties to perform. A plain reading of these covenants in the agreement would lead no prudent person to come to reasonable inference that, all that the assessee companies were doing was to transport soft drinks from point to point and nothing else. All the accounts of the assessees, which had been subject matter of assessment and which disclosed sales and not transport charges, do not support the finding of the AO and, on the contrary, they support the stand of the assessee. Thus, we have to necessarily conclude that the finding of fact by the AO was perverse, as the assessee was a distributor and not a transporter.
14. The second finding of the AO is that the non-compete agreement dated 19-9-1997 between the assessee company and BCC and the agreement for purchase of goodwill dated 19-9-1997 are dubious devices and subterfuges to avoid tax. BCC and the assessee company are separate and independent entities totally unconnected and unrelated to each other. BCC has purchased all the fixed assets as per the balance sheet of the assessee company at an agreed price. The transactions in question cannot be termed as transactions within the group of connected persons. The AO has not brought any evidence whatsoever to prove that these agreements are bogus agreements. As stated earlier, all that the AO wanted to say is that "If I were to decide the matter by getting into the shoes of BCC, then I would not have made this payment". To hold that a transaction is a colourable device, there should be something more than mere surmises and conjectures. The fact remains that BCC has paid the assessee certain amounts in pursuance of an agreement entered into between them and the axability or otherwise of these amounts has to be considered by applying the settled law to these agreements. Merely saying that we do not believe these agreements, without an iota of evidence, cannot be countenanced. Even if it is to be held that the assessee had arranged its affairs in such a manner as to minimise its tax liability, then it has to be held that a citizen has the freedom to act in a manner according to his requirement, his wishes in the manner of doing any trade, activity or planning his affairs with circumspection within the framework of law.
15. Heavy reliance was placed by the Commissioner of Income-tax who represented the Department before us, on the judgment of the Hon'ble Supreme Court in the case of Mc Dowell & Co. v. CTO 154 ITR 148. Courts have considered this judgment of the Hon'ble Supreme Court on a number of occasions and it has been held that one is unable to read into the aforesaid decision that any act of an assessee, which results in reduction of his tax liability or expediting tax benefit in future, amounts to a colourable device, a dubious method or a subterfuge to avoid tax. When acts are unambiguous or bona fide, the apparent has to be treated as the real unless the contrary is proved.
16. The ratio laid down by the Hon'ble Supreme Court in the case of Mc Dowell & Co. (supra) has been explained by the apex court in the case of Union of India v. Azadi Bachao Andolan 263 ITR 706 at 759, as follows:
We may in this connection usefully refer to the judgment of the Madras High Court in M.V.Valliappan v. ITO , which has rightly concluded that the decision in McDowell cannot be read as laying down that every attempt at tax planning is illegitimate and must be ignored, or that every transaxction or arrangement which is perfectly permissible under law, which has the effect of reducing the tax burden of the assessee, must be looked upon with disfavour. Though the Madras high Court has occasion to refer to the judgment of the Privy Council in IRC v. Challenge Corporation Ltd. [1987] 2 WLR 24, and did not have the benefit of the House of Lords' pronouncement in Craven's case [1988] 3 All ER 495(HL); [1990] 183 ITR 216 (HL), the view taken by the Madras High Court appears to be correct and we are inclined to agree with it.
We may also refer to the judgment of the Gujarat High Court in Banyan and Berry v. Commissioner of Income-tax where referring to McDowell's case , the court observed:
The court nowhere said that every action or inaction on the part of the taxpayer which results in reduction of tax liability to which he may be subjected in future, is to be viewed with suspicion and be treated as a device for avoidance of tax irrespective of legitimacy or genuineness of the act; an inference which unfortunately, in our opinion, the Tribunal apparently appears to have drawn from the enunciation made in McDowell's case [1958] 154 ITR 148 (SC). The ratio of any decision has to be understood in the context it has been made. The facts and circumstances which lead to McDowell's decision leave us in no doubt that the principle enunciated in the above case has not affected the freedom of the citizen to act in a manner-according to his requirements, his wishes in the manner of doing any trade, activity or planning his affairs with circumspection, within the framework of law, unless the same fall in the category of colourable device which may properly be called a device or a dubious method or a subterfuge clothed with apparent dignity.
This accords with our own view of the matter.
At page 762 of the report, it was observed:
If the court finds that notwithstanding a series of legal steps taken by an assessee, the intended legal result has not been achieved, the court might be justified in overlooking the intermediate steps, but it would not be permissible for the court to treat the intervening legal steps as non est based upon some hypothetical assessment of the "real motive" of the assessee. In our view, the court must deal with what is tangible in an objective manner and cannot afford to chase a will-o'-the wisp.
[Emphasis supplied by us] Hon'ble Supreme Court in the case of CIT, AP v. Motor & General Stores Pvt. Ltd. 66 ITR 692, at 699, observed:
In the absence of any suggestion of bad faith or fraud the true principle is that the taxing statute has to be applied in accordance with the legal rights of the parties to the transaction. When the transaction is embodied in a document the liability to tax depends upon the meaning and content of the language used in accordance with the ordinary rules of construction. In Bank of Chettinad Ltd. v. Commissioner of Income-tax it was pointed out by the Judicial Committee that the doctrine that in revenue cases the "substance of the matter" may be regarded as distinguished from the strict legal position, is erroneous. If a person sought to be taxed comes within the letter of the low he must be taxed, however great the hardship may appear to the judicial mind to be. On the other hand, if the Crown seeking to recover the tax cannot bring the subject within the letter of the law, the subject is free, however apparently within the spirit of the law the case might otherwise appear to be.
This judgment was followed in the case of CIT v. B.M. Kharwar 72 ITR 603 (SC), and also applied in the case of Bombay Burmah Trading Corporation Ltd. v. CIT 81 ITR 777 (Bom.). We have, therefore, to examine the transactions as embodied in the document and the liability to tax depends on the true meaning and context of the language used in the agreements between the parties.
17. In the case on hand, the agreement between Spectra and the assessee company was a distribution agreement and all these years, the assessee had been purchasing soft drinks from Spectra and selling the same. In none of the previous assessment years the Revenue had taken a contention that the only income that the assessee got was transportation charges and not sales. On the contrary, all the balance sheets indicate that the turnover of the company was only sales of soft drinks, which included an element of transport, but not mere and simple transportation charges. Thus, the contention of the Revenue fails. There is no suggestion from the Revenue that this agreement was a colourable device or subterfuge.
18. Coming to the next contention of the Revenue that the treatment of the payment in the hands of TCCC has to be considered for the purpose of scertaining whether the receipt in question is a capital receipt or a revenue receipt, we find that it is against the settled propositions of law. To give an example of the case of a real estate businessman, sites and buildings are his stock-in-trade and sale of the same is a revenue receipt. But, if a buyer buys it as a capital asset, then it would be a capital expenditure in the hands of the buyer and just because the real estate dealer treated it as a revenue receipt, the buyer cannot claim the same as his revenue expenditure. Similarly, on the contra, if a company or an individual has a fixed asset, being land and building, which it holds for a number of years as investment/fixed asset and sells the same to a real estate agent who deals in property, then in the hands of the seller it is a capital receipt and in the hands of the buyer, who is a real estate agent, it is a revenue expenditure. The legal propositions in this regard are fairly well settled.
19. Hon'ble Supreme Court in the case of Empire Jute Company Ltd. v. CIT 124 ITR 1, held:
It is not a universally true proposition that what may be a capital receipt in the hands of the payee must necessarily be capital expenditure in relation to the payer. The fact that a certain payment constitutes income or capital receipt in the hands of the recipient is not material in determining whether the payment is revenue or capital disbursement qua the payer.
In the case of CIT v. Vazir Sultan Tobacco Co. Ltd. 36 ITR 175, Hon'ble Supreme Court observed:
While thus indicating that an agency could be treated as a capital asset of the business this Court guarded itself against its being understood as deciding that the compensation paid for cancellation of an agency contract must always and as a matter of law be held to be a capital receipt and it made the following pertinent observations:
Such a conclusion will be directly opposed to the decision in Kelsall's case and Commissioner of Income-tax v. South India Pictures Ltd. The fact is that an agency contract which has the character of a capital asset in the hands of one person may assume the character of a trading receipt in the hands of another, as, for example, when the agent is found to make a trade of acquiring agencies and dealing with them.
[Emphasis is ours] The apex court went on to observe:
The agency agreements in fact formed a capital asset of the assessee's business worked or exploited by the assessee by entering into contracts for the sale of the. Charminar cigarettes manufactured by the company to the various customers and dealers in the respective territories. This asset really formed part of the fixed capital of the assessee's business. It did not constitute the business of the assessee but was the means by which the assessee entered into the business transactions by way of distributing those cigarettes within the respective territories. It really formed the profit-making apparatus of the assessee's business of distribution of the cigarettes manufactured by the company. If it was thus neither circulating capital nor stock-in-trade of the business carried on by the assessee it could certainly not be anything but a capital asset of its business and any payment made by the company as and by way of compensation for terminating or cancelling the same would only be a capital receipt in the hands of the assessee.
[Emphasis is ours] Thus, we hold that the manner in which TCCC had treated this payment in its books of account does not in any way help in coming to a conclusion as to whether the receipt in question was a capital receipt or a revenue receipt. 20. Now, we consider the terms of the agreements and the tax effect. In the Non-compete Agreement dated 19-9-1997, it was mentioned as follows:
1. Scope of Agreement
a) In, consideration of the amount set' forth below, the Covenantor covenants and agrees that, for five (5) years from the execution hereof the Covenantor shall not at any time disclose to any person for any purpose or use any Confidential Information in any business or venture; either directly or indirectly through any person, firm, company or other body corporate in which the Covenantor owns equity or otherwise, in and around the state of Andhra Pradesh.
b) Covenantor further agrees that after the execution hereof it shall use all reasonable endeavours to prevent the publication or disclosure of any Confidential Information.
c) For purposes of this Agreement, Confidential Information shall mean all information (including that comprised in or derived from manuals, instructions, catalogues, booklets, data disks, tapes, source codes, formula cards and flow charts) relating to the business of the Covenantor and that of BCC, if any, in possession or the control, of the Covenantor and the services provided.
d) At any time after the execution hereof, Covenantor shall not do anything which might prejudice carrying on by BCC of the business of bottling and distribution of TCCC trademarked products.
2. Each covenant contained in this Agreement shall be construed as a separate covenant and if one or more of the covenants is held to be against the public interest or unlawful or in any way an unreasonable restraint of trade, the remaining covenants shall continue to bind the Covenantor.
3...
4. The Covenantor shall promptly refer to BCC all enquiries relating to the business of the Covenantor as existing prior to this Agreement and assign to BCC (so far as it is able) all orders relating to the business which the Covenantor may in future receive.
5...
6. The Covenantor shall not during the subsistence of this Agreement, whether directly or indirectly, engage or acquire or continue to maintain an investment interest in any other entity engaged whether directly or indirectly in the business of distribution or transportation of soft drink beverages. Notwithstanding anything contained in this Section, the Covenantor may continue to distribute or transport any product or provide services in respect of any product other than soft drink beverages.
A plain reading of these covenants contained in the agreement clearly indicate that there was an impairment of the capital structure or profit making apparatus to the extent of the products specified in the agreement. The assessee had specialised knowledge, business control and expertise and experience along with reputation and goodwill in the field of distribution of soft drinks as is evident from the activities carries on and the returns filed by the assessee for the last several years and in pursuance of the above referred agreement, the assessee was prohibited from distributing soft drink beverages. He is also prevented from disclosing to any person any confidential information and it is provided that it shall be the endeavour of the assessee to prevent the publication or disclosure of any confidential information. The assessee is also prevented from doing anything which...might prejudice BCC's business of bottling and distribution for a period of five years and shall also promptly refer to BCC all enquiries relating to the business of distribution of soft drinks. In the agreement for purchase of goodwill, in clause 5 at page 3, the assessee is required to even change its registered name within 60 days. The distribution agreement with Spectra formed a capital asset of the assessee's business, and this distribution agreement was a means with which the assessees entered into business transactions and that which the assessees worked or exploited. The distribution agreement constituted or formed part of the fixed capital of the assessees' business and it was neither the stock-in-trade nor the circulating capital of the assessees. It really formed the profit making apparatus of the assessees' business.
21. It is necessary to bear in mind the following principles enunciated by various courts, including the Hon'ble Supreme Court. -
(A) In the case of Blue Star Ltd. 217 ITR 514, Hon'ble Bombay High Court observed that if a payment is made to compensate a person for cancellation of a contract which does not affect the trading structure of the recipient's business nor deprive the recipient of what in substance is the source of income, termination of the contract being a normal incident of the business, and such cancellation leaving the recipient of the amount free to carry on his trade, the receipt is 'revenue'. However, whereas by the cancellation of agency, the trading structure of the assessee is impaired or such cancellation results in the loss of what may be regarded as the source of the assessee's income, payment made may be regarded as one made for the loss of the source of the assessee's income, and such payment made to compensate for such cancellation of agency is normally a 'capital receipt'.
(B) In the case of CIT v. Dr. R.L Bhargava 256 ITR 42, Hon'ble Delhi High Court extracted the following observations of Hon'ble Bombay High Court in the case of Raliwolf Ltd., 143 ITR 720, to come to the conclusion that if there had been no absolute parting by the assessee with the technical know-how and consideration was received for imparting know-how, not in association with the disposal of a capital asset, such receipt should be treated as a revenue receipt:
The legal opposition on these authorities, therefore, is that know-how is not strictly a fixed asset and the nature of receipts from the know-how would essentially depend upon the transactions out of which the receipts arise and the context in which the receipts are received. If the imparting of know-how is really in the nature of services rendered without anything more, the receipt must be treated as a revenue receipt. But when consideration is received for impairing in association with the disposal of a capital asset, then the receipt will have to be treated as a capital receipt.
(C) In the case of Vadilal Soda Ice Factory v. CIT 80 ITR 711, Hon'ble Gujarat High Court observed that if the amount was received as compensation for loss of profit, it was a revenue receipt liable to tax.
(D) In the case of K. Ramasamy v. CIT 261 ITR 358, Hon'ble Madras High Court observed that if the purpose of the deed of compensation in reality was only to screen the payment made under that deed from liability to income in the hands of the assessee, it should be treated as a revenue receipt.
(E) In the case of Ram Kumar Agarwalla and Brothers v. CIT 63 ITR 623, Hon'ble Supreme Court observed that if the consideration was received towards remuneration for services rendered and not for refraining from competing in the purchase of the controlling interest, the receipt must be regarded as a revenue receipt.
(F) In the case of CIT v. Manna Ramji and Co. 86 ITR 29, Hon'ble Supreme Court observed that in order to resolve the controversy as to whether a receipt is of revenue character or capital in nature, one must try to ascertain the true nature and character of the payment. In border-line cases, the controversy has to be resolved on the facts and circumstances of the individual case. If the payment is received on account of sterilisation and destruction of a capital asset and if the assessee was permanently deprived of a source of income, it could be held as a capital receipt; otherwise, it is a revenue receipt.
(G) In the case of CIT v. Shamsher Printing Press 39 ITR 90, Hon'ble Supreme Court observed that if an amount was received for an injury to the assessea's capital assets including goodwill, it would be treated as a capital receipt, and if it was received as a compensation for loss of profit, it was a revenue receipt liable to tax.
(H) In the case of Gillanders Arbuthnot and Co. Ltd. v. CIT 53 ITR 283, the apex court observed that there is no immutable principle that compensation received on cancellation of an agency must always be regarded as capital. If by cancellation of an agency the trading structure of the assessee is impaired, the payment should be treated as a capital receipt. In this regard, the court followed its earlier decision in the case of Kettlewell Bullen and Co. Ltd. v. CIT 53 ITR 261. Further, having regard to the vast area of business done by the assessee as an agent, it was held that the acquisition of agency was in the normal course of business and determination of individual agencies a normal incident not affecting or impairing the trading structure and, therefore, the amount received for the cancellation of such agency did not represent price paid for loss of a capital asset. However, if the compensation was for agreeing to refrain from carrying on a competitive business in the commodities in respect of the agency terminated, or for loss of goodwill, such receipt was field to be in the nature of a capital receipt.
(I) In the case of Godrej & Co. v. CIT 37 ITR 381, the apex court observed that although the language used in the resolution was not decisive and the question had to be determined by a consideration of all the attending circumstances, it could not be ignored altogether but had to be taken into consideration along with other relevant circumstances. It was further observed that if the compensation was for the deterioration or injury to the managing agency, the receipt is capital in nature.
(J) In the case of P.M. Divecha v. CIT 48 ITR 222, the apex court observed that if the payment was not received to compensate for a loss of profit of business, it cannot be described as income. To constitute income, profits or gains, there must be a source from which the particular receipt has arisen, and a connection must exist between the quality of the receipt and the source. If the payment is by another person, it must be found out why that payment has been made. It is not the motive of the person who pays that is relevant. More relevance attaches to the nature of the receipt in the hands of the person who receives it. Whether the amount: involved was large or was periodic in character has no decisive bearing. The description of the payment is not determinative of its quality. In that case, a firm which was conducting business in electrical gods entered into an agreement with a company under which the firm was given exclusive rights to purchase and sell electric lamps manufactured by the company. Upon termination of such agreement, the company paid compensation. The court observed that the agreement secured to the firm an advantage of an enduring nature and was not an ordinary trading agreement and thus the receipt is capital in nature.
(K) In the case of Addl. CIT v. Dr. K.P. Karanth 139 ITR 479 (AP), the assessee having technical know-how for manufacture of drugs, had given up his right to manufacture drugs and such receipt was held to be capital in nature.
(L) In the case of CIT v. G.R. Karthikeyan 201 ITR 866, Hon'ble Supreme Court observed that the expression "income." should be given a wider meaning and though an income is casual in nature, it can nevertheless be treated as income assessable to tax.
(M) In the case of Elegant Chemicals Enterprises P. Ltd. v. ACIT 271 ITR (AT) 56, this Bench had an occasion to consider the issue as to whether an amount received by the assessee is capital or revenue in nature. In that case, the Bench observed that the surrounding circumstances have to be taken into consideration to find out the reality of the recitals made in the documents, and by applying the test laid down by the apex court, it was held that the particular receipt was a revenue receipt liable for taxation. The Bench observed that the totality of the circumstances indicate that the trading structure of the assessee was not impaired and it was a normal incident of the business, i.e. loss of the future profits.
(N) In Kettlewell Bullen and Co. Ltd. v. CIT 53 ITR. 261, and Gillanders Arbuthnot and Co. Ltd. v. CIT 53 ITR 283, Hon'ble Supreme Court has laid down the principles that are applicable in the case of receipts on account of restrictive covenants. In Gillanders Arbuthnot & Co. (supra), it was observed:
It cannot seriously be disputed that compensation paid for agreeing to refrain from carrying on a competitive business in the commodities in respect of which agency was terminated or for the loss of goodwill as prima facie being of the nature of a capital nature.
(O) Visakhapatnam Bench of the Tribunal in the case of M/s Ambica Chemical. Products, Eluru, v. DCIT, Circle I, Eluru I.T.A. No. 238/V/2003, dated 26-5-2005, considered at length the case laws on restrictive covenant as well as the effect of the insertion of Clause (va) to Section 28(ii) with effect from 1-4-2003, and the taxability under Section 55. As that order of the Tribunal was available to both the parties and as it has been relied upon at length, for the sake of brevity, we do not reproduce the extracts from the order Suffice it to say, that decision is in line with the pleadings of the assessee before us.
(P) The order of Hyderabad Bench 'B' of the Tribunal in the case of V.C Nannapaneni (supra) supports the case of the assessee. Both the assessee and the Revenue placed reliance on that order. As regards a number of other cases cited by both parties, we observe that the propositions in those cases are applicable to the peculiar facts of those cases only. Suffice it to say, each case turns on the peculiar facts of that case, the general propositions of law remaining the same, i.e. law as enunciated by the Hon'ble Apex Court in Various jugements. Thus, the amount has been received by the assessee for covenants which have caused impairment to the income earning apparatus of the assessee, and for sterilisation and destruction of a capital asset as it is not to carry on a particular line of business i.e distribution of soft drinks for a particular period due to which the assessees herein were deprived of a source of income. The covenants affect or impair the trading structure itself of the assessees before us and thus, it is a capital receipt.
22. To sum up, the recent decision of the Hon'ble Calcutta High Court in the case of CIT v. Saroj Kumar poddar, 279 ITR 573, wherein it has considered various High Court judgments as well as the judgment of the Hon'ble Supreme Court, is applicable to the facts of this case. At page 576 to 578, the Hon'ble High Court observed as follows:
In CIT v. Best and Co, (pvt.) Ltd. the respondent was a company carrying on business including distribution of their explosives of Imperial Chemical Industries (Experts) Ltd., Glasgow. The Imperial Chemical Industries (Experts) Ltd., Glasgow., decided that all its agencies i India should be taken over by the Imperial Chemical Industries (India) Ltd., and gave notice to the respondent terminating the agency from April Ist 1948. On termination of the agency some compensation has been paid which includes the compensation for undertaking of the assessee that assessee for five years shall refrain from selling or accepting any agency for explosives competitive with those covered by the agency agreement. The question before their Lordships whether the amount of compensation for the "non-compete agreement " is a revenue receipt. Their Lordship held that receipt is a capital record and not taxable, At page 22 their Lordship observed as under:
In the present case, the covenant was an independent obligation undertaken by the assessee not to compete with the new agents in the same field for a specified period. It came into operation only after the agency was terminated. It was wholly unconnected with the assessee's agency termination. We, therefore, hold that part of the compensation attributable to the restrictive covenant was a capital receipt and hence not assessable to tax.
[Emphasis is ours] In Gillanders Arbuthnot and Co. Ltd. v. CIT [1992] 46 ITR 847 (Cal), the issue before this Court was that the compensation received on termination of several agencies, as consideration for termination, whether the receipt in the form of compensation should be treated as capital receipt. This Court held that as the undertaking not to engage in a competitive business was not given, no part of the compensation money was received by the assessee on condition not to carry on competitive business in explosives. consequently no part thereof was exempted from the Income-tax Act.
In CIT v. Bombay Burman Trading Corporation [1986] 161 ITR 386 (SC), the issue before their Lordship was what should be the nature of compensation received against termination of lease of cutting and removing timber. Their Lordships held that the amount of compensation receipt is a capital receipt.
In CIT v. Saraswathi Publicities , the issue before the Madras High Court was what should be the nature of the compensation received under the agreement to refrain from carrying on competitive business. The Madras High Court, following the decision of their Lordships of the Supreme Court in the case of CIT v. Best and Co. (Pvt.) Ltd. [1966] 60 ITR it, has taken the view that the amount of compensation is a capital receipt and not liable to income-tax.
In CIT v. Automobile Products of India Ltd. , the assessee was manufacturing diesel engines in collaboration with a foreign company. Due to paucity of foreign exchange the assessee has transferred its undertaking and given up the licence for manufacture of engines to some other company. The giving up of the licence has affected the profit making structure of the assessee's business for that he received the payment against the loss of opportunity to make profits under the collaboration agreement taken in conjunction with industrial licence. The court held that the amount received as compensation is a capital receipt.
In CIT v. Late G.D. Naidu , the dispute before the Madras High Court was that the compensation received by the assessee for not carrying on bus business for five years, whether the payment was "restrictive covenant" is a revenue receipt. The deceased and his son with others were partners in five different firms carrying on business. During the year 1963-64 relevant for the assessment year 1964-65, all the old partners of the firms retired in stages so that by April 1, 1964 all the various firms were composed of entirely new groups of partners. The deceased and his son were paid varying amounts by the various firms to ward off competition from them in regard to the bus service business.
The firms in their assessments claimed this amount as revenue expense. The assessee (deceased and his son) claimed that the amount received from the various firms towards restrictive covenant is not taxable as it is a capital asset. The Madras High Court has taken the view that the amount of compensation is not liable to tax either as income or capital gains.
From the decisions referred above it is made clear that if the amount of compensation has been received not to compete in business from the person who paid the amount, the amount received cannot be taxed as income.
23. The main contention of the Revenue as per the ld. Dept. representative is that the receipt in question is compensation in connection with termination of agency, for which reliance has been placed on Section 28(ii). Section 28(ii) as it stood for the impugned assessment year reads as follows:
28. Profits and gains of business or profession.
The following income shall be chargeable to income-tax under the head "Profits and gains of business or profession",-
i)...;
(ii) any compensation or other payment due to or received by,-
(a) any person, by whatever name called, managing the whole or substantially the whole of the affairs of an Indian company, at or in connection with the termination of his management or the modification of the terms and conditions relating thereto;
(b) any person, by whatever name called, managing the whole or substantially the whole of the affairs in India of any other company, at or in connection with the termination of his office or the modification of the terms and conditions relating thereto;
(c) any person, by whatever name called, holding an agency in India for any part of the activities relating to the business of any other person, at or in connection with the termination of the agency or the modification of the terms and conditions relating thereto;
(d) any person, for or in connection with the vesting in the Government, or in any corporation owned or controlled by the Government, under any law for the time being in force, of the management of any property or business;.
A new clause, Clause (va), was introduced with effect from 1-4-2003, which was not in the statute during the impugned assessment years, reads as follows:
(va) any sum, whether received or receivable, in cash or kind, under an agreement for-
(a) not carrying out any activity in relation to any business; or
(b) not sharing any know-how, patent, copyright, trade-mark, licence, franchise or any other business or commercial right of similar nature or information or technique likely to assist in the manufacture or processing of goods or provision for services:
Explanation.-For the purposes of this clause,--
(i) 'agreement' includes any arrangement or understanding or action in concert, (A) whether or not such arrangement, understanding or action is formal or in writing; or (B) whether or not such arrangement, understanding or action is intended to be enforceable by legal proceedings;
(ii) 'service' means service of any description which is made available to potential users and includes the provision of services in connection with business of any industrial or commercial nature such as accounting, banking, communication, conveying of news or information, advertising, entertainment, amusement, education, financing, insurance, chit funds, real estate, construction, transport, storage, processing, supply of electrical or other energy, boarding and lodging;
The first issue is whether the provisions of this clause is declaratory or retrospective in nature, as this clause was not in the Act during the impugned assessment year. We do not think so. The provision introduced is of substantive character. The legislature has not made this amendment retrospective either expressly or by necessary implication. On the contrary, it Is specifically stated that it is with effect from 1-4-2003. Hon'ble Supreme Court in the case of Mahendran and Ors. v. State of Karnataka and Ors. , has laid down:
Every statute or statutory rule is prospective unless it is expressly or by necessary implication made to have retrospective effect. Unless there are words in the statute or in the Rules showing the intention to effect existing rights, the rule must be held to be prospective. If a rule is expressed in a language which is fairly capable of either interpretation, it ought to be construed as prospective only. In the absence of any express provision or necessary intendment, the rule cannot be given retrospective effect in matter of procedure.
In coming to the conclusion that Clause (va) of Section 28, which was introduced with effect from 1-4-2003, is not retrospective or retroactive in nature, we draw strength from the following case laws:
Shyam Sunder and Ors. v. Ram Kumar and Anr. (2001) 8 SCC 24;
Gem Granites v. CIT 192 CTR 481 (SC);
S.S. Gadgil v. Lal & Co. 53 ITR 231 (SC);
K.M. Sharma v. ITO 254 ITR 772 (SC);
National Agricultural Co-operative Marketing Federation of India Ltd. and Anr. v. Union of India and Ors. 260 ITR 548 (SC).
A.P. Civil Supplies Corporation Ltd. v. DCIT 83 ITD 398 (Hyd);
Sri Chaitanya Educational Committee v. CIT, Central Circle-I, Hyderabad I.T.A. No. 887/Hyd/2004, ITAT, 'B' Bench, Hyderabad.
24. That leaves us with the issue as to whether the receipt in question falls within Clauses (a) to (d) of Section 28(ii). The case of the Revenue is that the receipt falls specifically within the ambit of Section 28(ii)(c). Before dealing with this issue, we once again, at the cost of repetition, state the facts to the extent they are relevant for determination of this particular issue.
25. The agreement of distribution was entered into between Spectra and the assessee company on principal to principal basis in the year 1994. It was neither an agency agreement nor an agreement for managing the whole or substantially whole affairs of any company. There is nothing on record to show that this distribution agreement was terminated either by Spectra or by the assessee. There is no agreement between BCC and the assessee, which can be termed as an agency agreement. BCC has paid an amount to the assessee on its own and the document does not show that it was paid for the termination of any agency, nor was the payment made at the instance or on behalf of Spectra.
26. Thus, on a plain reading of Section 28(ii) and applying the same to the facts of this case, we are unable to persuade ourselves to agree with the contentions of the learned DR (CIT). What Section 28(ii) specifically deals with is with reference to compensation for general termination of agency or modification of terms and conditions relating thereto. These provisions were brought in only in the context of managing agency agreements. The assessee in its own right distributed products bottled by Spectra in pursuance of a distribution agreement, which definitely is not an agency agreement. The first appellate authority, in the case of Kode Enterprises P. Ltd., in his order dated 11-3-2002, observed at paragraph 8, page 9. as follows:
I agree with the Appellant's submissions. Invoking the provisions of Section 28 and discussing the various case law by the A.O. from para 43 onwards is not relevant as appellant is not a ¦ management agent nor the agreement with Spectra was an agency agreement. So I hold that the provisions of Section 28 do not apply to the agreement entered into by the Appellant with that of BCC.
We agree with the findings of the first appellate authority at paragraph 8 on page 11 of his order that the receipt in question does not fall within the ken of Section 28(ii) of the Act. Thus, the receipt in question was for restrictive covenant inasmuch as the assessee had carried on the business in soft drinks and had established a distribution network and market for itself and this business was discontinued at the instance of TCCC who started their own network of distribution of soft drinks manufactured by them and had entered into an agreement whereby the assessee was restrained from carrying on its business in soft drinks any longer for a particular period of time, i.e. 5 years, and the assessee had even to change its name and if it so desired to start a separate and distinct line of business in compliance with the agreement. This resulted in the entire business structure of the assessee in the line of soft drinks distribution being impaired or destroyed. This is not compensation received for termination of Agency. Thus, what the assessee received was a compensation for loss of its source of business and not compensation for loss of income or profit and thus it was a capital receipt not exigible to tax.
27. This brings us to the issue of goodwill. As already discussed, the perception of the AO that there is no requirement for BCC to pay goodwill to the assessee company as it was a mere transporter and not a distributor and dealer in soft drinks is not borne out by record or evidence. On the contrary, the assessee submitted the following statistics which show that they were marketing products of Spectra as distributors and there was substantial improvement in the business of the assessee:
Particulars Assessment year
1996-97 1997-98 1998-99
Sales 5,31,24,821 11,43,03,420 11,29,28,752
Other Income 3,20,186 2,74,825 13,51,296
Profit for the year 23,71,844 88,19,305 1,04,42,471
The agreement of goodwill clearly shows that BCC acknowledged the fact that the assessee company had goodwill and had agreed to pay for the same. The basis on which such goodwill is to be quantified is given in the agreement itself. We do not understand as to how the Revenue contends that there is no goodwill whatsoever in this case, especially when the assessees have developed a distribution network and have achieved sales figures in crores of rupees. The AO cannot simply state that he disbelieves the agreement, as in his perception there is no goodwill whatsoever, that too without any rhyme or reason. We are dismayed at the observations made by the AO which are without an iota of evidence that the agreement in question is a make-believe agreement.
28. The Hon'ble Supreme Court, in P.C. Cooper v. Union of India 40 Co. Cases 325, observed that "Goodwill of a business is an intangible asset; it is the whole advantage of the reputation and connections formed with the customers together with the circumstances making the connections durable. It is that component of the total value of the undertaking which is attributable to the ability of that concern to earn profits over a course of years or in excess of normal amounts because of its reputation, location and other features. Goodwill of an undertaking, therefore, is the value of the attraction to customers arising from the name or reputation for skill, integrity, efficient business management or efficient service." (p. 385).
29. At para 9 on page 8 of the order of the CIT (A) in the case of M/s Sri Kode Enterprises (P) Ltd., the first appellate authority held as follows:
I also do not agree with the Assessing Officer's observation that the Appellant company did not have any goodwill. Goodwill is an intangible asset and the valuation of which is of little cumbersome procedure. Even according to the Assessing Officer the Appellant company cannot compete with a giant like Coca-cola Then why should Coca-cola pay large sums of amount to the Appellant. Certainly this is not charity. Unless, the Coca-cola finds the importance of the Appellate company in damaging its business interest in India, there is no necessity to pay any amounts to the Appellant company. As there are two agreements with which the Appellant was first prevented in undertaking the same business and next in disclosing the information in its possession and also for purchase of goodwill. The goodwill was offered to tax so the observation of the A.O. that it did not offer same to taxation in para 2 was not correct. What the Appellant did was to claim exemptions under capital gains provisions which was permitted under statute. The Assessing Officer is not correct to analyse the issue of goodwill as this issue is in the purview of two companies and they have entered into these agreements after analysing the issues and negotiations with various bottlers and agents. Hence, the amount of goodwill received by the Appellant company is to be treated as goodwill alone and as Appellant company disclosed this and offered to tax as a goodwill, there is no need to treat this as a revenue receipt. Moreover even the Coca-Cola treated them as Goodwill only and claimed depreciation thereon. Hence,I direct the A.O. to treat it as goodwill to be taxed under capital gains.
We fully agree with his view and uphold the same. Thus, this ground of the Revenue is dismissed.
30. Though there is no specific ground taken by the Revenue, the AO had invoked the provisions of Section 50(2) at paragraph 65 of his order and the learned CIT (DR) has referred to the same. Firstly, this issue cannot be gone into by the Tribunal as not even an additional ground is taken by the Revenue. The Tribunal's powers are strictly confined to the subject matter in the appeal, as held in - (1) CIT v. Krishna Mining Co. 117 ITR 702 (AP); (2) CIT v. Late Begum Noor Banu Alladin 2.04 ITR 166 (AP); (3) Hukumchand Mills Ltd. v. CIT, Central, Bombay 63 ITR 232 (SC); and (4) Pathikonda Balasubba Setty (Deceased) v. CIT 65 ITR 252 (Mysore). Thus, mere mention by way of reading the order of the AO does not empower us to go into the issue. Even otherwise, Section 50(2) refers to block of assets ceasing to exist as such by reason of transfer of the entire "block of assets". The term "block of assets" is defined in Section 2(11) of the Act and comprises of certain tangible assets as well as intangible assets, but the primary requirement is that a rate of depreciation has to be prescribed i.e., in other words the asset should be a depreciable asset. E.g., "land" does not fall in a "block of assets" though it is a tangible asset. Thus, an amount received for a restrictive covenant cannot be said to have been received for transfer of an asset which forms "part of a block of assets". The AO has not stated as to how he considers these receipts as those which are received for transfer of "block of assets" nor has he given any finding that in fact, after the transaction, there are no more assets left in the block. Without a factual finding that the block of assets ceased to exist, Section 50(2) cannot be invoked. Even if it is taken as a capital asset, then, on merits, the assessee relied on the decision of the Visakhapatnam Bench of the Tribunal in the case of M/s Ambica Chemical Products, Eluru, v. DCIT, Circle I, Eluru I.T.A. No. 238/V/2000 for asst. year 1996-97, order dated 26-5-2005. The issue of levy of capital gains has been discussed at length from page 39 onwards in that order. For ready reference, we reproduce below the relevant portion of the order:
19...Thus, the main question before us is whether for agreeing to such covenant to chargeable capital gains under Section 45 of the Income-tax Act. For the levy of capital gains under Section 45 three ingredients should co-exist: (1) there should be a capital asset; (2) there should be transfer of such capital asset; and (3) profit or gain must arise from the transfer of such capital asset. So far as the first two ingredients were concerned, there is no dispute on assessee's side that the right to manufacture or agreeing not to manufacture whole would constitute a capital asset within the meaning of Section 2(14) and further that the aforesaid clause in the agreement constituted transfer of a capital asset as per the definition contained under Section 2(47). However, with regard to the third ingredient regarding profits or gains arising from agreeing to not to manufacture the scented agarbathi and not to compete with AAA directly or indirectly over a period of 20 years, the provisions concerning computation of capital, gains as contained under Section 48 which contain three basic elements, viz., cost of acquisition and cost of improvement as well as date of acquisition for working out the capital gains are not applicable as these essential ingredients are not ascertainable and, therefore, computation provisions would be incapable for computing the capital gains. The charging section and the computation provisions together constitute an integrated fiscal code. In the present case computation provisions contained under Section 48 failed and, therefore, consideration received for agreeing not to manufacture would not fall within the purview of charging section.
20. Section 45 is a charging section. For the purpose of imposing the charge, the Parliament has enacted detailed provisions in order to compute the profits or gains under that head. No existing principle or provision at variance with them can be applied for determining the chargeable profits and gains. All transactions encompassed by Section 45 must fall under the governance of its computation provisions. A transaction to which those provisions cannot be applied must be regarded as never intended by Section 45 to be the subject of the charge. This inference flows from the general arrangement of the provisions in the Act where under each head of income the charging provision is accompanied by a set of provisions for computing the income subject to that charge.
21. In the case of Sunil Sidharthbhai v. CIT (1985) 156 ITR 506/23 Taxman 14W, the Supreme Court has observed that the provision of Section 48 is fundamental to the computation machinery incorporated in the scheme relating to the determination of the charge provided in Section 45 and where Section 48 cannot be effectuated, such a case must be regarded as falling outside the scope of capital gains taxation altogether. Right to manufacture has been generated over a period since the assessee was engaged in this business. It would not be possible to conceptualise the cost of acquisition of such a right as well as date of acquisition thereof. If the cost of acquisition and/or the date of acquisition of the asset cannot be determined, then it cannot be brought within the purview of Section 45 for levy and computation of capital gains. Looking to the nature and character of the capital asset being the right to manufacture/or carrying on the particular business, in the instant case, the consideration realized by the assessee would be outside the purview of capital gains under Section 45.
22. Regarding date of acquisition and cost of acquisition, this essential fact was truly unascertainable and understandably, no attempt had been made by the Assessing Officer to identify the same. The. Assessing Officer had sought to overcome the difficulty by treating the consideration as if colourable device has been adopted by the assessee to evade the taxes. Even the assessing officer went on by observing it is some sort of long term lease ignoring the fact that 'right to manufacture or right to carry on business' is a capital asset. Thus, in our opinion, computation provisions failed and no capital gain would be chargeable under Section 45. If the law fails to bring the subject within the latter, the department cannot succeed with the argument that the subject falls within the spirit of the law. It is a settled law that if the computational provisions contained under Section 48 cannot be satisfied, no capital gain is leviable on the transfer of capital assets in view of the following decisions:
1) CIT v. B.C. Srinivasa Setty
2) Evans Fraser & Co. Ltd. (In Liquidation) v. CIT
3) Addl. CIT v. Ganpathi Raju Jogi Sanyasi Raju
4) Addl. CIT v. Ganpathi Raju Jogi
5) Bawa Shiv Charan Singh v. CIT
6) CIT v. Markapakula Agamma (1987) 63 CTR (AP) 108 : (1987) 165 ITR 3 (AP)
7) CIT v. Chive Mills Co. ltd. (In Liquidation) (1983) 36 CTR (Cal) 300 : (1986) 148 ITR 14 (Cal)
8) CIT v. Suman Tea & Plywood Industries (P) Ltd.
9) Srikrishna Dairy & Agricultural Farm v. CIT (1987) 65 CTR (AP) 44 : (1985) 169 ITR 291 (AP) .
10) Addl. CIT v. K.S. Sheikh Mohideen
11) Voltas Ltd. v. Dy. CIT (1998) 64 ITD 232 (Mum) The legislature was also fully aware of this legal position and therefore it has amended Section 55(2)(a) and consequently incorporated the definition of the 'cost of acquisition' in respect of number of all assets and profit for taking cost of such assets to be Nil. Initially, the amendment was made to take the cost of good will to be Nil with effect from Asst, Year 1988-89. Thereafter with effect from Asst. Year 1995-96, the cost of acquisition of tenancy rights to be Nil, With effect from Asst. Year 1998-99, the cost of acquisition of the right to manufacture, produce and process any article or thing was taken to be Nil and thereafter from the Asst. Year 2002-03, the cost of trade marks associated with the business was taken to be Nil, Finally with effect from Asst. Year 2003-04, it has been provided that the cost of acquisition of right to carry on any business is taken to be Nil. Till the said amendments no capital gain is leviable on the transfer of any of the above assets for the simple reason that the computational provisions of Section 48 failed, They were all, capital assets and technically, taxes under the head 'Capital gains' is chargeable on the transfer in terms of 45,. but only because their cost of acquisition and their cost of improvement in terms of 48 was not ascertainable in respect of these assets no capital gain, tax was chargeable on the transfer of these assets. We find that the case of assessee relate to the A.Y. 1996-97. The amendment in Section 55(2)(a) in respect of a "right to manufacture, produce of process any article or thing" came w.e.f. 1.4.1998 and therefore prior to the A.Y. 1998-99, no cost can be assigned to such asset. There does not seem to be any decided Case where the provisions of Section 55(2)(a) are held to be retroactive. The provision of Section 55(2)(a) is to be regarded only as a substantive provision. So, it has only prospective operation. The computational requirements of Section 48 are not satisfied, and so, no tax is leviable in terms of Section 45 on the consideration received on agreeing not to manufacture scented agarbathies and consequently not to compete with the AAA on these agarbathis. The judgment of Hon'ble Supreme Court in the case of CIT v. B.C. Srinivasa Setty is fully applicable.
We fully agree with the same. As there is no sale of asset in the "Block of assets" which gave rise to this receipt, Section 50(2) has no application. Further, we specifically find that the impugned agreement, from which the receipt in question flowed, fails within the ambit of CLAUSE(Va) of Section 28 and as this clause is not applicable to the impugned assessment year, no tax is leviable. Similar view was taken by Hyderabad Bench 'B' of the Tribunal in the case of DCIT v. Era Software Systems Pvt. Ltd. I.T.A. No. 489/Hyd/2003 for asst. year 1999 2000, order dated 27.9.2005.
31. In the case of K.V.D. Prasad Rao, Hyderabad, v. ACIT, Circle 3(1), 12-2001, which is specifically relied upon by the Revenue, a specific finding was given that the circumstantial evidence proved the stand of the Revenue that the assessee resorted to a tax saving ruse. There was abundant materiel before the Tribunal to come to such a conclusion, unlike in the case on hand. In this case, there is no material to question the genuineness of the covenant in the agreement dated 19-9-1997. The order in that case turns on the peculiar facts of that case and it was specifically held that the non-compete fee received therein was only part of the sale consideration. In our view, that decision does not come to the rescue of the Revenue.
32. Thus, looking at. the issue from any angle, for the reasons stated above, we uphold the orders of the first appellate authority in all theses cases.
34. In the result, these appeals of the Revenue are dismissed.